What would be a great tax cut for the masses has not generated even a second's discussion in the federal election campaign.
Lower the GST and HST on mutual fund and exchange-traded fund fees and we instantly fatten up the returns of the many people who use these investing vehicles to save for retirement and other goals. Whoever forms the next government should give this some thought.
Say an investor puts $5,000 annually for 25 years in a mutual fund with an average annual return of 5.8 per cent after fees of 2.2 per cent (fund returns are always reported on an after-fee basis). A recent report by the Montreal Economic Institute estimates that taxes would cost $7,307 over that period of time. At $10,000 a year, the investment gains lost to tax come to about $14,614; at $20,000 a year, the amount lost to tax is $29,228.
Mathieu Bédard, the economist who wrote the report, said people either have to save more to offset the impact of taxes on mutual fund returns, make do with less or delay retirement. "After 25 years, we're talking about a really substantial amount of money."
The $1.2-trillion mutual fund sector has been raising the issue of sales taxes on funds for years with the federal Department of Finance without any evident traction. Joanne De Laurentiis, president and CEO of the Investment Funds Institute of Canada, said the industry prefers to approach taxes as a policy matter rather than running the risk of trying to insert it into an election campaign and then seeing it get overlooked. "Once the election is done, it's certainly on our agenda to bring it back to finance officials," she said.
IFIC says Canada is an outlier among the more than 140 countries with GST-like sales taxes in taxing mutual funds rather than exempting them. Canada is also the only country applying federal and provincial tax rates, thereby adding cost and complexity.
It's unlikely that governments would give up their entire tax haul from mutual funds. But even a modest pullback would be useful at a time when longer lifespans are putting more pressure on people to save for retirement. The MEI report notes that the government encourages this kind of saving through tax-free savings accounts and registered retirement savings plans, but then undermines itself by taxing mutual fund assets.
Lowering sales taxes on mutual funds won't have the appeal of the more targeted tax cuts being talked about in the election campaign for the likes of single or widowed seniors, homeowners and the middle-class. It's a measure a government takes because it's good policy, rather than a vote getter.
The MEI report says mutual funds account for about 27 per cent of financial investments in Canada, with the rest spread out between savings accounts, pension plans and individual stocks and bonds. Knock funds all you want for their high fees, but there's no avoiding the fact that they're the go-to investment for a lot of Canadians.
In fact, taxes are a factor in making mutual fund fees as high as they are. Mr. Bédard said GST is applied on the operating and management expenses a fund incurs, and in jurisdictions with an HST, provincial sales taxes also apply. All of these costs are reflected in a fund's management expense ratio (MER), which is the definitive measure of how much it costs to own a mutual fund.
Taxes are also a factor in ETFs, where fees are much lower than mutual funds. You'll typically notice a small differential between the management fees charged on an ETF and the MER. The people at BlackRock Canada report that for their iShares ETF products, this difference is mainly accounted for by sales tax.
Mr. Bédard said it's the unique structure of mutual funds that results in their fees being taxed. The net result is that around 8.2 per cent of the management fees for mutual funds are accounted for by sales taxes, compared to between 1 and 3 per cent for guaranteed investment certificates and zero on stocks and bonds that are directly purchased.
Sales taxes on funds do not reflect the rates of the province where an investor lives, Mr. Bédard noted. Instead, fund companies use an average of sales taxes applied in different provinces, with a weighting for each made according to how many clients are in each province. This means that investors in Alberta, where there is no provincial sales tax, still end up paying some tax on their mutual funds. It also means that the HST in provinces like Ontario is nudging up the cost of sales taxes in non-HST provinces.
Mr. Bédard said businesses can generally be reimbursed for the GST and provincial sales taxes they pay, but mutual funds are an exception. He said the easiest way to reduce the sales-tax hit on funds would be to put them on the same footing as pension funds, which can be reimbursed for 33 per cent of the sales taxes paid.
IFIC's Ms. De Laurentiis acknowledges that taxation of funds is a complicated matter because all investments, not just funds, would need to be considered. Still, her group is pursuing the matter. One reason may be that easing the tax load on funds would help the fund industry a little bit with an image problem related to high fees. But investors would also win, Ms. De Laurentiis said. Money not paid in sales taxes would remain with investors and have the opportunity to compound over the years. "That would be more money in the investor's pocket."